Interest rates are low and the stock market is rallying, but corporate bond yields are still high

25

Argus published an interesting note this morning that looks at how corporate bond yields are still much higher today than they were a year ago, despite the drop in the Federal Funds rate to near zero and the accompanying quantitative easing by the Fed and the recent rally in the stock market.

As one can see, interest rates are particularly high right now for anything other than the highest rated companies. This is great news for bond investors who are seeking attractive yields, but not so great news for corporations in need of funds.

Investors seem to have been spooked by the looming bankruptcy of General Motors and possibly Chrysler and they are concerned, rightfully so, that default rates are destined to head higher in the current weak economic climate.

Ultimately if rates in corporate bonds don't begin to drop by this summer, Argus believes that it is very likely that the Federal Reserve and the Treasury will begin purchasing longer term corporate bonds in an effort to force yields lower.

The large spread between corporate bonds and Treasuries provides investors who purchase corporate bonds today with some protection should interest rates begin to rise. This, combined with the Fed and Treasury's determination to keep interest rates low, my belief that this slowdown will last much longer than many currently think, my sticking to bonds that mature in less than 10 years, and my willingness to hold my bonds to maturity should provide me from quite a bit of protection against any implosion in the value of my portfolio of bonds.

Speaking of bonds that I currently own, I added a decent position in Textron senior corporate debt several months ago. At the time, these bonds with maturity dates in the summer of 2010 had yields to maturity of around 20%. Yes, Textron has a lot of problems, but it also has a lot of quality assets including Cessna jets, Bell helicopters, and a decent business with the Department of Defense. I won't bore you with the specifics, but so far my bet is panning out.

Textron's common stock is up nearly 50% this morning on a rumor that a group of companies from the United Arab Emirates and Kuwait are interested in purchasing the company for $21/share with the intention of keeping the Cessna and Bell divisions and selling off the military business.

Lockheed Martin and Raytheon are also rumored to have been looking at Textron.

Where there's smoke there's fire. I personally think that there is a very good chance that part or all of the company will be sold off over the next several months. Any large cash injection to Textron or its complete sale would likely be great news for its bond holders.

Textron corporate bonds were all over the place a few months ago. Even smaller investors like myself could have purchased as much as they wanted. Since then, someone seems to have scooped up all of the outstanding debt betting on a takeover. I just looked a little while ago and I can't find any Textron bonds available for sale on Schwab.

The lesson that I take away from this is to focus on companies that have real, tangible assets and valuable brands when investing in distressed debt.

Nice post Deej. I always appreciate your thoughtful, researched blog on a site where so many are posting nothing but pessimism and government bashing. It's good to remember that no matter how bad things are, there are always opportunities. Sometimes you just have to look a little harder.